[lbo-talk] Krugman

Doug Henwood dhenwood at panix.com
Mon Dec 17 13:31:55 PST 2007


On Dec 17, 2007, at 3:47 PM, Seth Ackerman wrote:


> In the context of this thread, it's important to point out that "the
> housing boom" means two distinct things. One was the bubble in house
> prices, which certainly falls into the category of speculative frenzy
> generating fictitious profits. The other was the boom in house
> *construction*, which doesn't really fall squarely into that category.
>
> The first category is exemplified by the investor who bought an
> existing
> house and then flipped it for a (fictitious) profit - fictitious in
> the
> sense that the profit didn't correspond to any actual production, it
> just redistributed money from the guy who bought low and sold high to
> the guy who did the reverse.

You're right, with the additional point that the new construction ultimately did a lot to undo the bubble, by increasing supply in excess of demand.

It's also the case that nonfinancial firms have been shoveling out cash to shareholders for much of the last 25 years, through takeovers and buybacks. The Fed's flow of funds accounts were set up with the implicit assumption that net equity issuance would be positive - that is, firms would finance their activities in part through the issue of new stock. That was mostly true from 1952 (when the quarterly FoF accounts begin) through 1982 (when the great bull market began). Since 1982, however, net issuance has been negative, meaning that firms retired more stock than they issued. The main vehicles for that retirement have been takeovers (when one firm buys another, the target firm's stock disappears) and buyback (when firms buy their own stock to boost its price). Net equity issuance was a record -6% of GDP in the third quarter of 2007, beating the previous record of -5% set in 1998. Before that, the record was just under 4% in 1988. Before 1982, the biggest net negative was -0.8% in 1981. It was never less than -0.5% before 1981.

Sooo...you could conclude from that that nonfinancial firms have found it more attractive to ship cash to their shareholders than invest in the underlying business. But the pressure to do that came from Wall Street, not from the firms themselves. If you go back to the early 1980s, the onset of the shareholder revolution, theorists like Michael Jensen insisted that managers were wasting shareholders' cash on capital expenditures when they should instead be distributing the cash. Of course, that cash goes into the pockets of institutional investors, who then pour it back into the financial markets. But, weirdly, that behavior continued despite high profit rates in the late 1990s, and from 2003-2006.

Doug



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